How Does a Limited Liability Partnership Work?
A limited liability partnership is different from a general partnership because a partner is not liable for the negligence or nuance of the other partners in the LLP. It also takes the features of both partnerships and corporations. For example, a partnership alone will not offer each partner limited liability in case of debt or lawsuits. However, an LLP offers all partners protection from such instances, just like corporations.
Limited Liability Partnership vs. LLC
- The most notable difference between an LLP vs. LLC is its basic definition. In a limited liability partnership, owners are known as partners, while in an LLC, the owners are known as members.
- For limited liability protection, partners in an LLP are protected from liability against the debt and negligence of their fellow partners, whereas an LLC protects members from business debts and any legal actions against the business as an entity.
- Members of an LLC can either hire a management team or get members into the management. However, partners in an LLP have to manage the partnership themselves, based on the agreement they have in the partnership agreement.
- There are a lot of tax options for an LLC. It can either get taxed as a corporation or as an S corporation. The S corporation option means that all corporate incomes and losses and other deductions are passed to the shareholders for tax purposes. An LLP is only taxed as a partnership.
Limited Partnership vs. Limited Liability Partnership
Limited partnership and Limited liability partnership are often mistaken. While an LLP will limit partners' liability, limited partnerships will limit liability for some partners. This exception in a limited partnership means that one partner must be listed as the general partner and thus has unlimited liability. The other partner then needs to have limited liability. In addition, limited partners do not have significant amounts invested in the business, hence cannot also participate in most decisions.
Limited liability partnerships are formed and registered in the state where the business is located. These partnerships need to formally register as LLPs and formally declare it in their forms. Many states only allow professionals to form LLPs, although a few others limit this chance to some chosen professions such as doctors and lawyers.
The following are primary steps required by all states to form a limited liability partnership;
- Verify your qualification status since some states only allow a few chosen professions to form limited liability partnerships.
- Pick and register the "Doing Business As" (DBA) name. This name needs to be different from other registered businesses in your state.
- Draft a limited liability partnership agreement that defines the roles and responsibilities of each partner. This document also indicates the capital contribution of each partner and how profits and losses will be distributed.
- The partnership then needs to designate a registered agent with a physical address to conduct business in the state.
- Apply and file for a certificate of limited liability partnership.
- Register for an Employer Identification Number (EIN), a requirement by the IRS for tax purposes. In addition to the EIN, businesses may also need to apply for a state ID number in some states.
- Acquire the necessary federal, state, and local licenses and permits.
- Some states also require limited liability partnerships to purchase insurance coverage before starting operations.
- Lastly, states like New York require limited liability partnerships to publish a detailed notice of formation in two newspapers that serve the county where the business is located.
Limited Liability Partnership Examples
There are two common limited liability partnership examples: professional organizations and licenses and limited vs. full shield.
- Professional organizations and licenses require every partner to have a professional license in their chosen field. For example, these LLPs may be partnerships by attorneys, architects, or accountants.
- A limited vs. full shield partnership is another example of a limited liability partnership. A limited LLP will limit the liability of the partners' debts if there is negligence or misconduct of another partner, employee, or agent associated with the business. On the other hand, a full shield offers protection within the partnership and from all partnership liabilities, such as the partnerships' creditors.
Advantages of LLP
There are many potential advantages of an LLP. Some of these include:
- Protection against liability is a significant advantage in an LLP. This partnership guarantees that the individual partners will not suffer personal liability for any negligent acts from the other partners, unlike in a general partnership.
- LLPs have a tax advantage since the partnership is not required to pay any taxes. Every partner is responsible for filing their income and self-employment taxes. All credits and deductions are also filed through the individual partners.
- LLPs have the flexibility advantage. A limited liability partnership ensures that partners decide their contribution to the business. The managerial roles are divided or separated based on each partner's experience. Partners can also choose to contribute financially but have no business or decision-making responsibilities.
Limited Liability Partnership Disadvantages
- A significant family limited partnership disadvantage is the tax issue, which is very complicated. Partners need to be careful to ensure that their business and the partnership are not similar to protect themselves from scrutiny by the IRS.
- Unlike general partnerships, a limited liability partnership is also not recognized as a legitimate business in every state. Some states will limit the professions that can register as a limited liability partnership, allowing just doctors and lawyers.
- Since the rest of the partners do not have to consult the participants in business agreements, one decision-maker may compromise the integrity of the whole business due to bad decisions. The problem is prevalent in cases where the partners did not create a partnership agreement from the beginning.
Lesson Summary
A limited liability partnership is a business where all partners share roles and responsibilities and have limited personal liability for any financial aspect of the business. To form a limited liability partnership, the partners must register the business with the necessary state agency. The limited liability aspect is the main difference between a general and limited liability partnership. A general partnership holds all partners liable for business debts and losses. A limited liability partnership also protects partners from any liability caused by the decisions or mistakes of the other partners. For example, if a decision made by one partner leads to a lawsuit, then they alone are liable. The rest of the partners are personally liable for the amount they invested in the business.
